Unit 3 Inventory Management

UNIT 3 INVENTORY MANAGEMENT
S.E Bolten states, “ The term ‘inventory’ refers to the

stockpile of the product a firm is offering for sale and the
components that make up the product.”
According to the Research Terminology Bulletin, the term
‘inventory’ means “ the aggregate of those items of tangible
personal property which (1) are held for sale in the ordinary
course of business, (2) are in the process of production for
such sale, or (3) are to be currently consumed in the
production of goods or services to be available for sale.”
OBJECTIVES / SIGNIFICANCE OF INVENTORY
MANAGEMENT
The objectives of inventory management may be
discussed under two heads:
(A) Operating Objectives:
(1)Availability of Materials
(2) Minimising the Wastage
(3) Promotion of Manufacturing Efficiency
(4) Better service to customers
(5) Control of Production level
(6) Optimal level of inventories
(B) Financial Objectives
(1) Economy in purchasing
(2) Optimum investment and efficient use of capital
(3) Reasonable Price
(4) Minimising Cost
NEED TO HOLD INVENTORY
1. Production and Sales Motive: Smooth production can be
ensured only when the raw material required for the
production is always available. Similarly, sales can go well if
the concern has sufficient production.
2. Precautionary Motive: It necessitates holding of inventory to
guard against the risk of unpredictable changes in demand
and supply forces.
3. Speculative Motive: It influences the decision to increase or
decrease inventory level to take advantage of price
fluctuations.
INVENTORY CONTROL
Inventory control is concerned with the acquisition, storage,
handling and uses of inventories so as to ensure the
availability of inventory whenever needed, providing
sufficient protection for contingencies, maximising economy
and minimising wastage and losses.The more efficient is the
inventory control, the less is the investment required.
Excessive investment in inventories increases costs and curtail
profits.
OBJECTIVES OF INVENTORY CONTROL
1. To minimise the possibility of delays in
production through supply of raw materials,
stores and spares, tools and other equipments
as an when required.
2. To avoid unnecessary capital being locked
up in inventories.
3. To exercise economies in ordering and
obtaining supplies and storage of materials
INVENTORY COST OR COST OF HOLDING INVENTORIES
1. Inventory Ordering Costs: These costs are known as ‘Set up

costs’ and ‘Acquisition costs’. It is cost of placing an order
and securing the supplies. It includes the use of
stationary,postage,telephone and telegraphs, advertisement etc.
2. Inventory Carrying Costs: Carrying costs are those costs
which are required to be incurred due to inventory storing
,handling,insurance etc. It also includes the interest cost due to
investment being locked up in inventories, rent of the godown,
the salaries and wages of the staff assigned in the duty to look
after the receipt, issue and proper storage of materials etc
3. Stock-out Costs: Stock-out cost is due to the non –stocking of
an inventory.
Essentials of Good inventory control System
1. Classification and identification of Inventories.
2. Standardisation and Simplification of Inventories
3. Adequate Storage facility
4. Setting Minimum and Maximum limits and Reorder Points
for each part of Inventory
5. Fixing Economic Order quantity
6. Adequate Inventory Records and Reports
Modern Techniques of Inventory Control
1. ABC Analysis: It has become an indispensable part of a business and the
ABC analysis is widely used for unfinished good, manufactured products,
spare parts, components, finished items and assembly items.
This method of management divides the items into three categories A, B and
C; where A is the most important item and C the least valuable.
Why the need for prioritizing inventory?
Item A:
In the ABC model of inventory control, items categorized under A are goods that
register the highest value in terms of annual consumption. It is interesting to note
that the top 70 to 80 percent of the yearly consumption value of the company
comes from only about 10 to 20 percent of the total inventory items. Hence, it is
crucial to prioritize these items.
Item B:
These are items that have a medium consumption value. These
amount to about 30 percent of the total inventory in a
company which accounts for about 15 to 20 percent of
annual consumption value.
Item C:
The items placed in this category have the lowest consumption
value and account for less than 5 percent of the annual
consumption value that comes from about 50 percent of the
total inventory items.
Note: The annual consumption value is calculated by the
formula:
(Annual demand) × (item cost per unit)
2. Determination of Maximum, Minimum, Re-order, Danger and
Average Levels or Setting of Various Levels
(a) Maximum Stock Level: The maximum stock level is that
quantity of material which the stock of any item should not
generally be allowed to go.
Maximum Stock level=(Reorder level +Re-order quantity)-
(Minimum consumption rate
Maximum Re-order period)
(b) Minimum Stock level: The minimum stock level is that
quantity of material which the stock of any item should not
go below it.
Minimum level= [ Reorder level –(Normal consumption*
Normal Reorder Period)]
(c)Reorder Level: The optimum order point or order level is the level of
inventory at which the economic order quantity of additional stock should
be ordered.
Reorder level= Maximum consumption Rate* Maximum reorder period
(d) Danger Level: Danger level is such a level at which the firm may suffer
heavy production and other type of looses. At this level the minimum
required raw material is purchased at any price.
Danger level= Minimum rate of consumption* Minimum reorder period
(e) Average Stock Level: Average Stock level represents the average stock
which is maintained in the stores. This level is above the minimum level
and below the maximum level.
Average level = ½( Maximum stock level + Minimum stock level)
EOQ: The Economic Order Quantity (EOQ) is the number of units that a
company should add to inventory with each order to minimize the total
costs of inventory—such as holding costs, order costs, and shortage costs.
The EOQ is used as part of a continuous review inventory system in which
the level of inventory is monitored at all times and a fixed quantity is
ordered each time the inventory level reaches a specific reorder point. The
EOQ provides a model for calculating the appropriate reorder point and
the optimal reorder quantity to ensure the instantaneous replenishment of
inventory with no shortages. It can be a valuable tool for small business
owners who need to make decisions about how much inventory to keep on
hand, how many items to order each time, and how often to reorder to
incur the lowest possible costs.
A company uses annually 50,000 units of an
item each costing Rs 120. Each order costs Rs
45 and inventory carrying costs 15% of the
annual average inventory value. Find EOQ

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UNIT 3 INVENTORY MANAGEMENT

S.E Bolten states, “ The term ‘inventory’ refers to the

1. Inventory Ordering Costs: These costs are known as ‘Set up

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